Buy Now, Pay Later Working For Afterpay

By James Dunn | More Articles by James Dunn

Established in 2015, Afterpay has developed a frictionless payments technology that enables shoppers to ‘buy now, receive now, pay later,’ in a manner that avoids using credit cards, borrowing any money, or paying any upfront fees or interest.

“Fintech” company Afterpay Holdings (AFY) is one of the stars of the micro-cap space. The payments disruptor listed on the ASX in May 2016, after raising $25 million at $1 a share in a heavily oversubscribed initial public offering (IPO), capitalising the company at $165 million.

The shares surged on to the market, at $1.30, and closed their first day 25% to the good. Since then, a string of mostly positive upgrades has helped the stock to move to $2.25, which capitalises Afterpay at $371.2 million.

But the stock is down from the highs above $3 it achieved in 2016, on market concerns of the impact of Afterpay’s proposed merger with its technology partner, digital payments software developer Touchcorp (TCH), which owns 26% of Afterpay. That potentially opens up some value.

Established in 2015, Afterpay has developed a frictionless payments technology that enables shoppers to “buy now, receive now, pay later,” in a manner that avoids using credit cards, borrowing any money, or paying any upfront fees or interest. Anyone registered on the Afterpay platform can buy a product, and pay later: Afterpay pays the retailer upfront and assumes all payment risk.

Afterpay then recoups the purchase value from the end-customer in four equal fortnightly payments, over a maximum term of 56 days. In return for being paid upfront by Afterpay, and handing off the payment risk, the merchant – not the shopper – pays Afterpay a fee.

Afterpay can be embedded into the retailer’s website or at the store counter. Each order placed through the Afterpay system generates a merchant fee. The merchant fees are based on a percentage of the end-customer order value, plus a fixed per-transaction fee.

Afterpay also earns a late payment fee if the end-customer does not have sufficient funds available to have payments collected automatically by the Afterpay system on the due payment dates. But Afterpay does not consider late payment fees as a primary revenue component – they are meant to act as an incentive for end-customers to pay on time, and merchant fees represent well over 80% of revenue. If a customer has overdue payments, the system will not allow them to make another purchase.

The company’s competitors include fellow ASX-listed fintech zipMoney (ZML), Zippay and Paypal, through its BillMeLater product.

But Afterpay has not been fazed by competition: its growth since listing has been impressive. In the company’s prospectus, released just ten months ago: Afterpay had 100 merchant clients on its books, 38,000 end-customers and $35 million in underlying annualised sales.

At the end of 2017, merchant numbers stood at 2,044, there were 356,766 end-customers and $444 million in underlying sales.
Just seven weeks later, when the company released its interim result, in mid-February, merchant numbers stood at 2,600, up 55% from the end of 2017. Afterpay customer numbers had jumped 26%, to 450,000, over the same period, while underlying annualised sales were up 8.1%, to $480 million.

The merchant roster is a cornucopia of Australia’s top retail brands: Optus, Cotton:On, Supercheap Auto, House, Mimco, R.M. Williams, Beacon Lighting, BCF, The Iconic, Country Road, Myer, Seafolly, Sportscraft and Rebel Sport are just a few of the names.

Afterpay and technology development partner Touchcorp have built on the success of the online offering to develop an in-store, point of sale version that effectively gives merchants a fully integrated “omni-channel” experience. Merchants are backing Afterpay’s argument that the in-store version of the buy-now, pay-later format induces people to buy on the spot, and/or increase the value of their purchase, boosting sales, while also allowing retailers to partially or wholly replace traditional lay-by services, which are generally costly and cumbersome for retailers to administer.

The company also contends that retailers showing the price of items – on its website and in-store – both in straight cash terms, and in the price of each instalment through Afterpay, boosts sales and acquires customers.

In its interim result presentation last month, Afterpay cited statistics from five clients – Veronika Maine, General Pants Company, Tony Bianco, Cotton:On and Cue – that showed that using Afterpay had boosted the retailers’ average purchase value by 18%–25%.

Moreover, using Afterpay had boosted the retailers’ conversion rates by 19%–28% (Cotton:On did not reveal this figure).

In particular, millennials – those people born between 1980 and 1999 – are the sweet spot for Afterpay. Where millennials are 28% of Australia’s population (the largest demographic group), they represent 73% of Afterpay’s transactions.

Afterpay worked with Touchcorp to build its system, which is based around an end-to-end digital platform and a “transaction integrity engine,” which conducts end-customer fraud and repayment capability assessments in real-time.

This allows Afterpay to make instant, automated decisions as to whether to provide instalment payment terms to any potential end-customer. The company’s privacy terms state that it can obtain information about end-customers from credit reporting bodies, but in practice, Afterpay says it only uses internal data, because it wants to “promote responsible behavior.”

The system cannot completely prevent bad debts, so there is a certain level of bad-debt risk in Afterpay. However, the engine assesses many attributes of the transaction and data in real-time and applies this information against rules – which are continually being updated – to determine whether to approve any particular transaction.

Fashion has been the sector in which Afterpay has gained the quickest, and largest, traction: the company says it has 10% share of the transactions in the $3.5 billion Australian online fashion retail market. This translates into 2.1% share of the $22 billion online retail market, and 0.2% of the $303 billion retail market in this country.

Afterpay is working on broadening into new retail sectors – helped by the average purchase size and conversion-rate statistics from some of its fashion partners – and expanding through partnerships with major retailers.

A good example is the two-year contract it signed this month with Myer, under which Myer will offer the Afterpay service to customers on its online service. (The announcement of this relationship stated that Afterpay now had 500,000 end-customers: broker Bell Potter estimated in January that the company was adding 1,000 customers a day.)

Another deal announced this month will see Afterpay’s service added to one of the world’s largest e-commerce platforms, the Australian-founded (but US-based) BigCommerce – which hosts 5,000 active Australian online merchants and more than 100,000 globally.

For the half-year ended December 31, Afterpay’s revenue ballooned to $6 million, up from $200,000 in the corresponding December 2015 half, and from $1.2 million in the June 2016 half. The company achieved positive operating EBITDA (earnings before interest, tax, depreciation and amortisation) for the first time, of $400,000, excluding one-off debt facility establishment costs and non-cash share-based expenses.

Underlying merchant sales were just under $145 million in the six-month period, while merchant fee revenue came in at $6 million.
The net loss after tax increased to $1.4 million, compared to a loss of $1.3 million in the prior corresponding period.

Last month, Afterpay and Touchcorp announced that they intend to merge, with a newly listed company formed to operate each business as subsidiaries, to be owned 64% by Afterpay shareholders and 36% by Touchcorp shareholders. On 23 February the parties began four weeks of merger negotiations.

The merger is a logical evolution of the relationship between the two companies, given the importance of the Touchcorp technology to the Afterpay offering, and the significant investment the pair have put into Afterpay’s technology platform. But the deal was seen by the market as more lucrative for Touchcorp shareholders, representing an almost 50% premium to the Touchcorp share price.

But Afterpay will also benefit, as the technology that underpins the Afterpay system will be brought in-house, and revenue opportunities flow from the combination of Afterpay’s retail network and Touchcorp’s strong technology offering, creating a payments software and technology company worth $500 million.

Considering Afterpay independently, according to Thomson Reuters’ collation, prior to the merger announcement, analysts expected Afterpay to break through to net profit in the current financial year, with earnings per share (EPS) of 0.3 cents. The analysts expected Afterpay to really get cooking in FY18, lifting EPS to 5.6 cents a share, and paying its first dividend, of 0.7 cents a share.

Profitability would be a welcome sight, given that the company raised $36 million through the issue of shares in October, and has about $31 million in cash on hand.

By then, Afterpay could be part of a larger business – and one in which its rapid growth is being held back by the Touchcorp business, which has not been growing as strongly. However, it’s the ability to gain economies of scale and efficiencies and leverage the way in which Afterpay has built such a strong retail business and network, that could be the drivers of a successful merger, in which Afterpay will be the senior partner.

It is difficult to assess the value of AFY – there is no relevant price/earnings (P/E) ratio or dividend yield, and matching the price to revenue doesn’t give you much to go on. A buyer now is banking on the merger working to deliver the mooted benefits.

About James Dunn

James Dunn was founding editor of Shares magazine and has also written for Business Review Weekly, Personal Investor, The Age and Management Today. He was subsequently personal investment editor at The Australian and editor of financial website,

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